HOW HEDGE FUNDS BEAT THE MARKET
Craig French and Damian Ko
This paper investigates the determinants of hedge fund portfolio performance—whether hedge funds exhibit security selection skill and market-timing skill. We examine a sample of 157 long-short equity hedge funds over the 10-year period from January, 1996 through December, 2005. To account for nonlinearities we employ the Treynor and Mazuy (1966) quadratic model. To account for illiquidity we incorporate the Scholes and Williams (1977) nonsynchronous data model. Before and after adjusting for illiquidity, we find strong evidence of security selection skill and limited evidence of market-timing skill.